Why, and how, you should trade the Twitter IPO

Commentary: Opportunities like this don’t come up very often

NEW YORK (MarketWatch) — On Oct. 16, I made an unhedged call to consider backing up the truck and buying Twitter shares upon its IPO — for a trade, though, not as an investment. After the stock begins trading in the open market, only skilled traders should consider entering a position. Now, I would like to describe the rationale for the call and also how to trade the stock after it hits the open market.

With this column being written before actual trading on the NYSE commences, let’s start by looking at an annotated planning chart. There are no trading prices in the chart, obviously, because Twitter
TWTR, -1.79%
was not trading when the planning chart was made.

First and most important, consider entering stops in the stop zone shown in red on the chart. The stop zone is $25.73-$25.97. If the syndicate bid at $26 is broken, consider exiting promptly.

The chart shows two potential targets, a low target and a high one. The low target shown in yellow is at $35. The high target shown in green is at $50. For guidance in between the IPO price and the two targets, a good way to plan is to look at Fibonacci retracements. The chart shows, in yellow, Fibonacci retracement levels from the low target and in green from the high target. Also consider moving the stop to protect profits right under the second Fibonacci retracement level under the stock price.

Finally, pay special attention to the price action. Consider staying with the trade as long as it traces a pattern of higher lows and higher highs.

An almost-free lunch

In the world of investments, free lunches are rare. To buy Twitter upon its IPO is one of those rare opportunities. The reason it is almost a free lunch is that the risk can be easily capped to a nominal amount as explained below, and the potential reward is substantial. In other words, the risk-to-reward ratio is dramatically skewed to the reward side.

There is very little risk for two reasons: First, the syndicate underwriting the IPO will maintain a bid at the IPO price. An astute trader can simply put a stop-loss order right under the syndicate bid.

Second, well-priced, high-profile IPOs tend to trace a pattern of higher lows and higher highs. If such a pattern is not traced, it will be a warning to sell immediately. In all likelihood, such a sale price will be higher than the IPO price, and the investor will end up with a gain even if the IPO does not perform well.

On the other hand, a trader can simply continue to hold shares as long as the pattern described above remains intact, easily generating a large gain. Demand is likely to exceed supply, and, as a result, the stock is likely to trade much higher than the IPO price.

It is important to note that it is not a completely free lunch because brokers tend to distribute hot IPOs only to their favorite clients and to sometimes impose restrictions on selling.

Facebook fiasco will not be repeated

The Facebook
FB, -1.82%
fiasco is still fresh in many investors’ minds. In all probability, the Facebook fiasco will not be repeated.

Facebook went public at $38, ran over $41, and then the syndicate bid at $38 was broken. The stock fell into the teens. The Facebook debacle was a result of glitches at the Nasdaq , Morgan Stanley
MS, -2.00%
and the company itself. Unlike Facebook, Twitter will trade on NYSE, and the lead underwriter is Goldman Sachs
GS, -1.86%

In all likelihood, the NYSE has learned from the Nasdaq’s problems; further, the NYSE model allows for human intervention, unlike the Nasdaq model.

There is no reason for Goldman not to structure its order book in a manner that most of the stock goes to strong hands.

Both the NYSE and Goldman have an opportunity to prove that they are better than the competition. In my analysis, they are likely to succeed.

The stock is expensive

My call on Oct. 16 was that Twitter will be priced at an enterprise value of $12 billion to $16 billion. The IPO is coming in at a valuation exceeding $14 billion. A relatively high valuation simply means that investors getting the stock in the IPO will make less gain.

By any measure, Twitter’s stock is very expensive. By some measures, it is more expensive than other social-media stocks, such as Facebook, LinkedIn
US:LNKD
Pandora
P, -2.08%
and Yelp
YELP, -1.31%

For this reason, this recommendation is for a trade and not for a long-term investment.

Barbell-portfolio strategy

For their technology holdings, investors may consider a barbell strategy. In my back testing, such a strategy is vastly superior in bull markets to holding a technology ETF such as Technology Select Sector SPDR
XLK, -1.96%

On one end of the bar, consider stocks like Apple
AAPL, -1.92%
Cisco
CSCO, -4.02%
and Microsoft
MSFT, -1.70%
which are cheap based on traditional fundamental ratios, growth prospects are mediocre, balance sheets are strong and momentum is lacking. For the other side of the barbell, consider a stock such as Twitter, which is growing fast, is speculative, and has the momentum.

Disclosure: Subscribers to The Arora Report have long positions in Twitter, Apple, Cisco, and Microsoft.

Nigam Arora is an engineer, nuclear physicist, author, and entrepreneur and the founder of two Inc. 500 fastest growing companies. He is also the developer of the ZYX Change Methodto profit from change by investing. The premise is that most money is made by predicting change before the crowd. Arora is the chief investment officer atThe Arora Reportand the editor of four newsletters that track the ZYX Change Method. Nigam can be reached atNigam@TheAroraReport.com

Nigam
Arora

Nigam Arora is an engineer, nuclear physicist, author, and entrepreneur and the founder of two Inc. 500 fastest growing companies. He is also the developer of the ZYX Change Method to profit from change by investing. The premise is that most money is made by predicting change before the crowd. Arora is the chief investment officer at The Arora Report and the editor of four newsletters that track the ZYX Change Method. Nigam can be reached at Nigam@TheAroraReport.com

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Nigam
Arora

Nigam Arora is an engineer, nuclear physicist, author, and entrepreneur and the founder of two Inc. 500 fastest growing companies. He is also the developer of the ZYX Change Method to profit from change by investing. The premise is that most money is made by predicting change before the crowd. Arora is the chief investment officer at The Arora Report and the editor of four newsletters that track the ZYX Change Method. Nigam can be reached at Nigam@TheAroraReport.com

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